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The First-Sale Doctrine in International
Intellectual Property Law:
Trade in Copyright Related
Entertainment Products
T H E O PA PA D O P O U L O S
The first-sale doctrine is a mechanism by which producers coordinate the
international distribution of copyright related entertainment products and is
the source of much litigation against unauthorised traders in copyright
product. This article presents an economic analysis of copyright and the
evolution of international intellectual property law. The objective is to
highlight a contentious issue in international law; namely, the timing of the
exhaustion of the right of first sale, and how this impacts upon trade in
entertainment products, particularly sound recordings. The article
demonstrates that international conventions, such as TRIPS, do not mandate
the adoption of national exhaustion.
Introduction
This article investigates the economics of copyright and the international
dimensions of trade in entertainment products, focusing on sound
recordings. Record companies, and multinational entertainment (MNE)
companies more generally, have utilised copyright law and the first-sale
doctrine to assist in the international coordination of territory (country)
specific distribution, pricing and marketing strategies. To be successful
these strategies must be backed by laws that prevent the establishment of
unauthorised distribution channels, whereby legitimate copyright product is
redirected from low-price to high-price markets. Parallel trade accounts for
a significant and growing proportion of world trade in patent, trademark and
copyright products, estimated to be in excess of $10 billion in North
America alone.1 This article is organised as follows. The second section
presents an economic analysis of intellectual property (IP) rights, followed
by an investigation of the evolution of international IP law in the third. This
lays the foundation for the review of the first-sale doctrine in international
Theo Papadopoulos is Senior Lecturer, Faculty of Business and Law, Victoria University,
Australia, and Coordinator of the Bachelor of Business – Music Industry programme.
Entertainment Law, Vol.2, No.2, Summer 2003, pp.40–60
PUBLISHED BY FRANK CASS, LONDON
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law and the controversy surrounding the exhaustion of copyright. This
analysis enables us to ascertain the legal obligation, with respect to
copyright exhaustion, imposed by membership of various international
copyright conventions, including TRIPS. A final section concludes.
Intellectual Property Rights
Intellectual property may be defined as the expression of an idea or concept
as a consequence of an individual’s creative endeavour. There are two main
branches of intellectual property: industrial property (including trademarks,
patents and industrial designs), and copyright (relating to literary and
artistic works). IPR law typically grants creators a bundle of exclusive
rights. These amount to economic rights that enable the commercial
exploitation of copyright product and are designed to encourage and reward
creative effort. This encourages technological progress by enabling creators
to derive financial rewards from their creations.
Intellectual property displays the public good characteristics of nonexcludability and non-rivalry. Non-excludability refers to the difficulty
faced by a creator in preventing unauthorised use. Non-rivalry means that
the use of the creation by one person does not prevent use by another.
Additional users neither reduce the quantity or the quality of the good. An
obvious example of non-rivalry is the distribution of literary or musical
works using the Internet where an infinite number of copies can be
reproduced at close to zero cost. It may be conceptually useful to consider
copyrightable creative works as ‘information goods’ in which the creative
work is fixed to an information carrier,2 for example, a musical work fixed
to a sound recording (CD or cassette). While rivalry and exclusivity exist
for individual copies of a CD, the musical work itself can be separated from
the original carrier and fixed to another. It is this separation and duplication
that gives rise to the public good characteristics of the sound recording, and
intellectual property more generally.
The public good nature of intellectual property, combined with high
establishment costs and low reproduction costs, encourages imitation.
Imitation of this kind is referred to as free riding: individuals waiting to
copy the creation rather than engaging in creative endeavour themselves.
The unauthorised commercial reproduction and distribution of intellectual
product is referred to as piracy. A deceptive trademark or design used to
‘pass-off’ an item as an original authorised product is typically referred to
as counterfeit product.
Granting exclusive rights to creators of intellectual property provides the
market power to commercially exploit the work and thereby provides the
economic incentive for the creation/production of intellectual property.
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Exclusive economic (monopoly) rights to the intellectual property helps to
eliminate free riding. Unfettered piracy would drive down the price of the
creative work to the marginal cost of reproduction rendering it commercially
unprofitable. Without the opportunity to exploit commercially the intellectual
property, creators may be unwilling to allocate resources to creative activities.
This would lead to market failure, the underproduction of intellectual
property. The protection of IPR via copyright law prevents free riding and
encourages the production of creative works.
A conflicting consequence of exclusivity, however, is a restriction in the
dissemination of the intellectual property that reduces consumption levels.
Dissemination increases consumption and thereby increases consumer
welfare. Minimal rights for creators will encourage dissemination and
enhance consumer welfare. This increased welfare has the consequential
cost of reducing economic returns to copyright owners and thereby
discourages creative endeavour. The static consumer welfare gains resulting
from increased dissemination may therefore be at the cost of foregone
dynamic gains resulting from decreased creative activity.
Numerous attempts have been made to construct economic models that
identify the optimal level of protection, portraying copyright law as a means
of achieving an efficient allocation of resources. While useful in helping to
conceptualise the key issues confronting regulators, these models provide
little hope of identifying the optimal level of protection. The information
constraints are simply too restrictive. For example, Landes and Posner3
depict the supply of creative works (q) as a function of price (p) and a
hypothetical index of copyright protection (z):
q = q (p,z)
(1)
Following this procedure we can modify equation (1) to depict the
consumption of creative works (c) as a function of p and z as follows:
C = c (p, z)
(2)
The higher (lower) are z and p, the lower (higher) is c and the higher (lower)
is q. That is, consumption is inversely related to copyright product price and
the level of protection, while the supply of copyright product is directly
related to copyright product price and the level of protection. The higher the
value of z, the higher the market power enjoyed by creators, and thereby the
higher the ensuing market price. The objective is to set z at a level that will
maximise national welfare (w),
w = w [c(p,z), q(p,z)]
(3)
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Equation (3) depicts national welfare as a function of both consumption and
production of copyright product, which in turn are a function of the level of
protection and price.
The key issue is how the level of protection, z, … is set along several
dimensions. In general, the modern law of copyright makes intelligent
estimates (about the level, breadth and duration of protection).
The challenge for policy makers is to set the appropriate level of market
power in a way that balances the interests of both producers and consumers.
The socially optimal outcome would be one in which the creator and/or
producer is rewarded for their endeavour with a (normal) profit, while
maximising consumption subject to the constraint of profitable commercial
application. This trade-off can be illustrated in a diagram measuring the
theoretical level of national welfare against varying levels of intellectual
property right protection, as presented in Figure 1.
F I GURE 1
T HE WE L FARE - P ROT E CTIO N TR A D E-O FF
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At low levels of protection (z1), creative works will be under-produced
because unrestricted competition at the commercial application stage will
result in significant levels of piracy. As the level of protection rises, the
production of creative works increases, thereby increasing consumption and
social welfare. Increased protection will enable creators to charge a higher
price and this will lower dissemination. Thus, while social welfare rises as
we move towards the optimal level of protection, this rise disguises a shift
in the distribution of income from consumers to producers of creative
works. This redistribution continues as the level of protection rises. Beyond
some theoretical optimal level of protection, depicted as z* in Figure 1, the
market power of copyright owners is so high that the costs of reduced
dissemination exceed the benefits derived from the production of additional
creative works.
In a sense, setting the level of copyright protection is an attempt at
balancing two welfare losses and gains. Increasing protection raises prices
and induces an increase in the production of copyright product. This reduces
welfare losses resulting from piracy and underproduction while at the same
time excluding potential consumers and thereby lowering consumer
welfare. In reality, the information constraints are so severe that setting the
optimal level of copyright protection is problematic. Referring to the first
order maximisation problem derived from a model for optimal copyright
protection, Koboldt states that it is obvious that:
the determination of the optimal level of copyright protection is a
difficult task and requires lawmakers to possess complete information
about the production technologies and demand structures. (p.147)
Clearly, policy makers do not, and will never have complete information.
Setting the optimal regulatory regime is made even more difficult by the
several dimensions of copyright protection, including the breadth, level and
duration of coverage, and the nature and severity of the penalties for IP
infringement. For this reason, the politics of competing interests often take
precedence over economic cost-benefit analysis in setting the regulatory
framework, without any clear notion of net social gain.
legal interest-balancing leads to no unique solutions, only acceptable
bargaining outcomes. The law can more easily recognize the existence
of competing interest than measure relative costs and benefits. Even
more to the point, interest balancing embodies no clear notion of net
social gain.4 (p.92)
While there may be little hope that economic analysis can resolve the
question of the appropriate scope of IPR protection it can nonetheless make
an important contribution to our comprehension of the multidimensional
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nature of copyright law and the challenges faced by policy makers in
attempting to set the optimal level and nature of protection. More precisely,
economic analysis can, at the margin, investigate and measure the likely
distributional consequences of different levels of copyright protection for
producers and consumers of copyright product and on overall social
welfare. Critical to this determination is the level of concentration of
ownership within various entertainment markets and the prevailing degree
of competition. Overprotection and the ensuing market power can result in
anti-competitive conduct that lowers economic efficiency. In the context of
international trade in entertainment product, the inclusion of a distribution
right, in which the creator of a copyright product can control its distribution
beyond the point of first sale, may introduce one such distortion. In the
following section we investigate the evolution of international IP law, as a
preview to considering the first-sale doctrine.
Evolution of International IPR Conventions
The importance of intellectual property in generating wealth for both
individuals and nations has led to concerted efforts at international level to
create a legal and institutional framework to foster the recognition and
protection of intellectual property. In 1886 ten nations established the
International Union for the Protection of Literary and Artistic Works by
signing the Berne Convention for the Protection of Literary and Artistic
Works (1886), the latest revision taking place in Paris and producing the
Berne Convention for the Protection of Literary and Artistic Works Paris
Act of July 24, 1971 (as amended on 28 September 1979). The primary
purpose of this convention was to provide foreigners with protection equal
to that enjoyed by local residents in member countries. The Berne
Convention rests on three basic principles:
•
•
•
National Treatment: copyright owners must be given protection in
member countries equal to that granted to their own nationals.
Automatic Protection: protection is not conditional on any formality,
such as registration (as is the case with a trademark, for example).
Independence of Protection: that protection granted is independent of the
existence of protection in the country of origin.
The Berne Convention provides protection for literary, dramatic, musical
and artistic works. Sound recordings and broadcasts were covered by the
inclusion of a category ‘subject matter other than works’. The Berne
Convention sets minimum standards of protection relating to the ‘economic
rights’ of creators. These exclusive rights include the right of:
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•
•
•
•
•
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Translation (Article 8)
Reproduction (Article 9)
Public Performance and Communication (Article 11)
Broadcasting (Article 11)
Adapting, Altering and other Alternations (Article 12)
The general rule in relation to minimum duration of protection is the
expiration of the 50th year after the author’s death. The Convention also
provides for certain ‘moral rights’ which bestow the right to claim
authorship and the right to object to any modification or mutilation of the
work that is detrimental to the author’s reputation. In recognition of the
welfare-reducing effects of excessive market power, a number of
exemptions to the bundle of exclusive rights are specified. Known as fair
dealing, this includes the recording or reproduction of works for private use,
research or study, criticism or review and reporting of news. As at 15
October 2000, the Berne convention had 147 member states (countries).
Efforts at protecting music copyright at the international level have not
been limited to the Berne Convention. The establishment of the
International Federation of the Phonographic Industry (IFPI) in 1933, today
representing some 1,700 record producers in over 70 countries, was
designed to focus efforts on enforcing intellectual property rights for the
music industry and to help thwart the growth in international music piracy.
The IFPI’s goal is to secure effective legislation to protect intellectual
property rights and to ensure adequate enforcement of that legislation.
Creating an international organization such as the IFPI was seen as a
means of establishing specific audio copyright legislation where it did
not exist, and at the same time harmonizing legislation so that piracy
and parallel imports were illegal.5
To help achieve this goal the IFPI negotiated the establishment of the
International Convention for the Protection of Performers, Producers of
Phonograms and Broadcasting Organisations, otherwise known as the
Rome Convention (1961), which unlike the Berne Convention was specific
to copyright in musical works, and designed to improve protection for
artists and record companies. Specifically, the Rome Convention grants:
1. performers exclusive rights to the communucation of their live
performance to the public, the fixation of their live performance (for
example, as a sound recording) and the reproduction of such a fi
performers exclusive rights to the communication of their live fixation;
2. producers of phonograms (sound recordings) the right to authorise or
prohibit the direct or indirect reproduction of their phonograms;
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3. broadcasters the right to authorise or prohibit the rebroadcasting of their
broadcast, the fixation and reproduction of any fixation of their
broadcast.
Burke asserts that the specificity of the Rome Convention discouraged
membership, which by 1970 amounted to only 11 countries. As at 15
October 2000 the Rome convention had 67 member states. Notably, as
many as 30 members signed only recently (during the 1990s) and the USA,
a major exporter of music product, is not a signatory.
In light of this failure and the need to continually upgrade and improve
international protection in the face of new challenges to the protection of
copyright, the IFPI negotiated the introduction of the Geneva Convention
for the Protection of Producers of Phonograms Against Unauthorised
Duplication of their Phonograms (1971). This convention was less onerous
on member countries compared with the Rome Convention and was
therefore more successful in attracting membership. By 15 October 2000
membership numbered 63 states and included the United Kingdom and the
USA. The main aim of the Geneva Convention was to combat the growth
of piracy, particularly international piracy, where large quantities of pirate
sound recordings were being distributed all over the world. International
piracy increased as a consequence of technological developments, namely
the shift from vinyl to audiocassette as the main sound carrier and the
development of hardware technology (such as the twin audiocassette deck).
These technological advances reduced the cost of duplicating sound
recordings and thereby stimulated music piracy. To address this the Geneva
Convention expressly prohibits:
1. the making of duplicates without consent of the producer,
2. the importation of such duplicates,
3. the distribution of such duplicates to the public.
The Berne, Rome and Geneva conventions are all implemented by an
agency of the United Nations (UN), namely the World Intellectual Property
Organisation (WIPO). Despite the comprehensiveness of these existing
treaties, many developing nations have yet to become signatories to these
international agreements, and some that did, failed to effectively enforce
domestic IPR laws. As net importers of intellectual property, developing
nations choosing to ignore the adoption and implementation of IPR laws are
able to free ride on the creative efforts of foreigners in developed countries.
it is in the narrow national interest of technology and entertainment
importing countries not to pay much attention to IPR protection,
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because this way they might be able to acquire IPR goods at a cheaper
price through imitation or copying.6
Technological progress has made copying of entertainment goods, such as
sound recordings and video games, a fairly simple and inexpensive process.
The next wave of sound carrier technology was the compact disc and digital
quality audio. CD-writers (or ‘CD-burners’ as they are often described)
provide the opportunity to produce perfect reproductions (or clones) of the
original sound recording. With the continuing reluctance of many countries
to enforce IPR regulations, developed countries, led by the USA and the
European Union (EU) pushed for the adoption of a new international treaty.
The forum chosen was not WIPO but the Uruguay Round of the General
Agreement on Tariffs and Trade (GATT), now the World Trade
Organisation (WTO). This new treaty was the Agreement on Trade-Related
Aspects of Intellectual Property Rights, Including Trade in Counterfeit
Goods (TRIPS), which came into effect in 1995. Developing countries were
induced to join TRIPS in return for the relaxation of controls over textile
and agricultural imports by developed countries. This was a strategic move
designed to extend membership to an international IPR convention, and
importantly, one that is backed by the power of the WTO to enforce the law
and impose penalties on rogue nations.
The TRIPS Agreement is the most comprehensive multilateral
agreement on intellectual property thus far and covers copyright,
trademarks, geographical indications (country of origin), patents, industrial
designs, designs of integrated circuits and trade secrets. In relation to
copyright, the TRIPS Agreement obliges members to comply with the main
provisions of the Berne, Paris, Geneva and Rome Conventions. One
advantage of negotiating an IPR agreement within the WTO is that it
automatically extends coverage to all WTO member countries, some of
which were not signatories to the WIPO conventions. In this way TRIPS is
expected to help curb the growth in international piracy. The three main
features of the TRIPS Agreement require:
1. a set of minimum standards to be provided by each member,
2. members to establish a set of domestic procedures and remedies for the
enforcement of IPR,
3. disputes to be subject to WTO settlement procedures.
It is this last element that makes the TRIPS agreement different from all
preceding IPR conventions. TRIPS departs from earlier IPR treaties in that
disputes between members will be subject to WTO settlement procedures,
where a WTO panel can impose trade sanctions on countries in violation of
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the TRIPS agreement. By comparison, WIPO was considered to be a
toothless tiger because of the absence of any effective enforcement powers.
There is an expectation among the net exporters of intellectual property
that TRIPS will bring about the international harmonisation of IPR laws.
Samuelson7 suggests this is both difficult and undesirable because:
national intellectual property laws are (especially copyright laws)
often intertwined with cultural values and policies that are deeply
connected to national identity. (p.97)
She expresses concern over the commodification of artistic and literary
works and suggests that the dominant values of free trade may bring about
a homogenised global culture. With WTO settlement procedures in place to
deal with disputes over IPR infringements, the cultural argument for
intervention may well be deemed protectionist and subject to challenge.
This potential loss of national autonomy and control over domestic cultural
activities is of concern to many. Weinstock8 presents a model of copyright
law in a framework of democracy rather than a mere item of international
trade. He notes that:
recent years have seen a dramatic move to reconceptualize copyright
in terms of international trade. TRIPS epitomized that move. It aims
to ratchet up worldwide copyright protection and enforcement in
order to remove barriers to copyright industry exports. (p.218)
There are few industries that do not rely on IPR protection of one form or
another, be it copyright, industrial design, or trade marks. The phenomenon
of globalisation is an inescapable process that is integrating markets and
economies. Music is a global industry and the development of harmonised
international IPR regulation is inevitable and will come at the cost of
national legislative, and perhaps cultural, autonomy.
Notwithstanding these developments, WIPO remains an important
international body in the protection of IPR and is collaborating with the
WTO on these matters. Two treaties were recently negotiated within WIPO
in 1996, the WIPO Performances and Phonograms Treaty (WPPT) and the
WIPO Copyright Treaty (WCT). These treaties are designed to update rights
in the context of new digital and Internet technologies. The WCT requires
signatories to comply with the main provisions of the Berne Convention and
deals specifically with computer software and databases. The WPPT, on the
other hand, deals with the IPR of performers (actors, singers, musicians,
etc.) and producers of phonograms. It was introduced in recognition of the
need to provide adequate solutions to the challenges of economic and
technological developments, and in particular, the impact of the
development of information and communication technologies, particularly
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the Internet, on the production and use of performances and phonograms.
Article 10, the ‘Right of Making Available of Fixed Performances’ and
Article 14 the ‘Right of Making Available of Phonograms’ provide
performers and producers with
the exclusive right of authorizing the making available to the public of
their performances fixed in phonograms, by wire or wireless means,
in such a way that members of the public may access them from a
place and at a time individually chosen by them. (WPPT)
The right of ‘making available’ is clearly designed to cover on-demand
communication of copyright material via the Internet. In the next section we
investigate one of the more controversial aspects of copyright protection:
the exhaustion of copyright and parallel trade.
Distribution Right and the Principle of Exhaustion
Copyright law in most countries bestows a bundle of rights on creators,
including the right to make copies available to the public. This amounts to
a right of first sale or distribution. However, copyright law generally
provides that the distribution right is exhausted with respect to a particular
copy, after the copyright owner or his/her licensee has sold that copy. The
principle of exhaustion means that the purchaser of the copyright product
can subsequently re-sell the product without the consent of the copyright
owner. It is for this reason that it is also referred to, principally in legal
literature, as the first-sale doctrine.
The principle of exhaustion lies at the heart of a contentious and
unresolved issue in international law; whether or not the copyright owner
should control distribution beyond the first sale. Under the principle of
international exhaustion (sometimes referred to as ‘universality’) the
exclusive right to distribute a work is extinguished after the first sale of a
particular copy anywhere in the world. The rationale behind this is that the
copyright owner, having sold the product, has obtained the benefit of
exclusive commercial exploitation rights bestowed by IPR law and should
no longer control its distribution beyond the first sale. Under the principle
of national exhaustion (or ‘territoriality’), however, the exclusive right to
distribute survives until the first sale of a particular copy within a specific
nation. The sale of a copyright product in one country does not extinguish
the right of first sale for that same copy in a second country.
The adoption of national exhaustion amounts to granting an importation
right in which only the copyright owner or their licensed agent can legally
import copies of a copyright product for distribution to the public. In effect,
this amounts to a prohibition on parallel imports. Parallel imports refers to
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copyright product manufactured within a specific territorial jurisdiction by
the owner of the copyright or their authorised licensee, which is then
imported for re-sale into another territorial jurisdiction by someone other
than that territory’s copyright licence holder.
The importation right enables copyright owners to partition the global
market into national segments, setting price according to the price elasticity
of demand in each segment, and thereby extracting monopoly profits.9 In
this context, it has been argued, that parallel imports provide effective
competition to authorised distribution channels, thereby breaking this anticompetitive strategy. Proponents of the importation right argue that parallel
import restrictions are expected to bolster the protection of copyright for the
owner or licensee within a specific territorial jurisdiction and remove
distortions arising from rivalry between licensees operating in different
(national) territories. The latter argument amounts to the utilisation of
government intervention (IPR law) to assist copyright owners in governing
the vertical distribution of copyright products.10
Copyright owners have also employed technological and contractual
measures to combat parallel imports, with limited success. In the motion
picture industry, for example, film studios and major DVD hardware
manufacturers agreed on a regional coding system in which discs encoded
for the USA (region 1) would not play on hardware sold in Europe (region
2). A regional coding system is also employed by the Sony Corporation on
its playstation video game consoles and software. Technological measures
of this nature are relatively easy to circumvent utilising modified players,
inserting chips that effectively convert the hardware into multi-zone
players. Indeed, some hardware manufacturers openly market multi-zone
DVD players, also capable of playing Video CDs (a pirate film format
particularly popular in Asia) and MP3 audio files, a popular format for the
digital distribution of free and pirate sound recordings over the Internet. The
film industry responded with regional enhanced coding on some discs,
rendering them unplayable on modified players. However, these measures
provide only temporary relief as circumvention technologies (both
hardware and software) quickly negate promised benefits to copyright
owners and their territorial distributors.
The contractual approach to inhibiting parallel trade has, likewise, had
limited success. Contractual arrangements may, for example, bestow
exclusive territorial rights but limit or indeed prohibit exports into other
territories. For the copyright owner, this facilitates the global coordination
of product release timing and pricing strategies, and limits cross-territorial
competition between authorised licensees and/or distributors. However,
since manufacturers typically sell to distributors, which in turn sell to
retailers, there are numerous points along the product distribution chain at
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which product can be diverted from low-price to high-price markets.
Copyright owners have only indirect and therefore limited control over third
parties along the distribution chain. It is for this reason that contractual
arrangements need to be backed by copyright laws that bestow an
importation right to effectively restrict parallel trade.
As a major copyright exporting country, the USA (encouraged by a large
and powerful copyright industry lobby), has been particularly vigilant in
maintaining (if not strengthening) importation rights embodied within
national copyright laws. For example, in 1997 the US Trade Representative
threatened to initiate proceedings against Australia in the WTO if it
proceeded with the planned amendment to the Copyright Act 1968 that
would allow parallel importation of sound recordings. This implied that
Australia would be in breach of its international obligations with respect to
the TRIPS Agreement. In the following section we review international IPR
law to evaluate the merit of this argument.
International IPR Law and the Exhaustion of Copyright
There are essentially two sets of international laws with respect to IPR,
those managed by the World Intellectual Property Association (WIPO) and
more recently, those embodied in the TRIPS Agreement of the WTO. An
IPR owner’s exclusive right to make the product available for sale is
incorporated in the Berne Convention, Rome Convention, and Geneva
Convention, as outlined above. Disputes arising between convention
member countries can be brought before the International Court of Justice.
Distribution is a key right identified in the WCT and WPPT. The WPPT
defines the right of distribution in Article 12 (paragraph (1)):
Producers of phonograms shall enjoy the exclusive right of
authorizing the making available to the public of the original and
copies of their phonograms through sale or other transfer of
ownership.
Importantly, Paragraph 2 of Article 8 explicitly avoids determination with
respect to the timing of the exhaustion of this right.
Nothing in this Treaty shall affect the freedom of the Contracting
Parties to determine the conditions, if any, under which the exhaustion
of the right in Paragraph (1) applies after the first sale or other transfer
of ownership of the original or a copy of the phonogram with the
authorization of the producer of the phonogram.
The text of WCT (Article 6) is identical except that it refers to the making
available of ‘literary and artistic works’ rather than phonograms. In other
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words, members of both conventions are free to determine the timing of the
exhaustion of the right of distribution and adopt the principle of national or
international exhaustion as they see fit.
Negotiations within the WTO, as evidenced in the text of the TRIPS
Agreement, have also left the controversial issue of the importation right to
individual national regulators. Article 6 of TRIPS deals with the issue of
exhaustion in the following way.
For the purposes of dispute settlement under this Agreement, subject
to the provisions of Articles 3 and 4, nothing in this Agreement shall
be used to address the issue of the exhaustion of intellectual property
rights. (Part I: General Provisions and Basic Principles)
Unable to agree on whether the principle of national or international
exhaustion should prevail, negotiators agreed to disagree and this question
was left to individual member states to determine at a national level.
Patented products would seem to be an exception to this rule as indicated in
Article 28, which confers the following exclusive rights:
where the subject matter of a patent is a product, to prevent third
parties not having his consent from the acts of: making, using,
offering for sale, selling, or importing (footnote) for these purposes
the product;
This would seem to suggest that patent owners have exclusive importation
rights and that member states are unable to adopt international exhaustion
with respect to patents. However, the footnote specific to the importation
right states that the rights conferred are subject to Article 6. This seemingly
contrary indication might be explained by Article 28, which prohibits
importation, or any other act specified therein, by third parties ‘without the
owner’s consent’. The making available or distribution of the patent product
in a member country would suggest consent and thereby enable third parties
to import and distribute copies first sold overseas.
The issue of the exhaustion of copyright has implications for the nature
of the bundle of exclusive rights and market power bestowed on copyright
owners, and thereby on the distribution of income between consumers and
producers of copyright product. Moreover, in an international context it can
impact upon the distribution of income and welfare among nations via its
impact on domestic prices and trade flows. This would seem to have been
recognised during the negations of the TRIPS agreement. Specifically,
Article 7 states that IPR laws should promote technological innovation,
transfer and dissemination:
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to the mutual advantage of producers and users of technological
knowledge and in a manner conducive to social and economic
welfare, and to balance rights and obligations.
This statement would seem to provide support for a policy of selective
international exhaustion by product class, as espoused by Donnelly.11 That
is, either national or international exhaustion should be adopted for specific
classes of products (for example, sound recordings, motion pictures or
video games) where it can be demonstrated that the adopted position
‘balances rights and obligations’ in a way that maximises social and private
efficiency. Indeed, Article 8 of TRIPS makes it clear that WTO members
have the right to adopt national rules and policies to prevent restrictive
practices by IPR owners.
Appropriate measures … may be needed to prevent abuse of IPR by
holders or the resort to practices, which unreasonably restrain trade or
adversely affect the international transfer of technology.
In specific product classes the exploitation of an importation right embodied
in the principle of national exhaustion may be deemed to ‘unreasonably
restrain trade’ and be detrimental to the national welfare of a member state.
Specifically, an importation right may enable copyright owners and their
licensees to extract monopoly profits from a specific territory at the expense
of domestic consumers. Indeed, the potential for certain types of licensing
arrangements to be anti-competitive was recognised within Section 8 of
TRIPS which explicitly deals with ‘Control of Anti-Competitive Practices
and Contractual Licences’. Article 40 enables member states to adopt
appropriate measures to prevent anti-competitive practices. Parallel import
prohibitions have been described, in some quarters, as anti-competitive and
the adoption of the principle of international exhaustion for the purpose of
removing price discrimination and/or collusive conduct by monopoly IPR
rights holders is consistent with this section of the TRIPS Agreement. It
would seem that under international law neither the WTO or WIPO treaties
prescribe either national or international exhaustion with respect to the
distribution right. This is supported by a range of literature on this legal
issue, to which we now turn.
In an investigation of patent rights under WTO laws, Bronckers12 seeks
to answer the legal question of whether the WTO obliges or prohibits
member countries from adopting international exhaustion. In doing so he
deliberately ignores the economic issues and welfare implications relating
to the timing of the exhaustion of the distribution right. In a review of the
negotiating history of the TRIPS Agreement, Bronckers points out that the
primary objective for developed countries was to improve the effectiveness
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of IPR protection in developing country markets. Moreover, the dispute
resolution mechanisms of the WTO would provide the necessary vehicle for
the effective implementation of enforcement measures against offending
member countries. This was something that was lacking in the WIPO
treaties. Under the dispute settlement mechanism of the WTO, a member
country can initiate the establishment of a tribunal to adjudicate alleged
violations by another member country. Importantly, WTO and TRIPS now
provide for cross-sectoral retaliation. If a member country infringes on
copyright, then the aggrieved national government can impose a punitive
tariff on another product, say clothing. Under the old GATT framework, the
country imposing the tariff would have been in violation of the GATT, see
Nimmer.13 Bronckers points out that, as disputes between parallel importers
and copyright owners or licensees often occur in the same country, WTO
and TRIPS are unable to assist in settling what are essentially domestic
disputes.
On the issue of the exhaustion of the distribution right, Bronckers
contends that TRIPS was not intended to rule on the issue of exhaustion of
IPR and that any creative interpretation to the contrary could not be used to
impose restrictions on member countries with respect to their ability to rule
independently on this issue. Citing a ruling by the WTO Appellate Body (to
which a member state can appeal if unsatisfied with the decision of the
tribunal) Bronckers demonstrates that in the context of ambiguity the less
onerous meaning (in terms of obligations and sovereignty of members) is to
be preferred to the more onerous:
Accordingly, from a WTO perspective, the discussion of the proper
policy to be followed by individual Member States on the exhaustion
of patent rights is entirely open. The WTO members must reconcile
their views on policy, rather than on law, where the exhaustion of
rights is concerned. Thus, if policy-wise it made sense to negotiate
different rules on exhaustion for patent rights than for trademark
rights, then there is nothing in WTO law that would prohibit this.
This conclusion is consistent with the policy options suggested by Donnelly
(note 14) regarding the adoption of selective international exhaustion by
product class, based on the economic costs and benefits unique to a specific
product. Donnelly presents an excellent review of the legal precedent
(judicial rulings) with respect to parallel imports and the exhaustion of
rights in the US, Japan and EU, highlighting the somewhat complex and
confusing legal environment within which traders are operating:
The current state of the exhaustion of rights principle internationally
is uncertain and ambiguous and the practical results of the fractured
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state of the law probably makes little sense to commercial traders …
The move towards the intellectual harmonization of intellectual
property laws is clear and growing.
However, attempts at international harmonisation to date, as evidenced by
the TRIPS Agreement, have proved difficult. Donnelly concludes that
harmonisation of laws is necessary and considers four harmonisation
models: international exhaustion, national exhaustion, selective
international exhaustion by product class, and rule of reason exhaustion.
National exhaustion, he argues, is inconsistent with the fundamental
principle of international harmonisation and the harmonisation of rules
within free-trade areas such as the EU and NAFTA. International
exhaustion would seem to be the simplest model but, given the diverging
views of numerous national governments on this issue, is not at present
feasible. For this reason, Donnelly suggests that the remaining two models
are achievable and consistent with present international IPR laws. Selective
international exhaustion by product class is a hybrid model of national and
international exhaustion:
Such a position has been investigated by the Japanese Ministry of
International Trade and Industry. One option considered was to
authorize parallel trade of products such as compact discs and watches
but bar parallel imports of products such as industrial machinery and
electrical goods.
The advantage of this model is that it provides the flexibility for policy to
respond to the specific circumstances prevailing in a particular product
market rather than apply either national or international exhaustion
universally. This approach is consistent with Article 6 of TRIPS whereby
each government is free to determine policy with respect to IPR law (patent,
trademark, copyright etc.) in each product class (sound recording, business
software, motion pictures etc.)
The Rule of Reason Exhaustion Model sets international exhaustion as
the default, with the possibility of an IPR holder making a case that the IPR
has not been exhausted by the first sale in another territory. Donnelly states:
The strength of such a model of harmonization is its ability to
accommodate many interests. On the one hand, it has as the default
rule international exhaustion which is both theoretically appealing and
most vigorously promotes free trade and movement of goods. On the
other hand, it affords intellectual property owners – acting through
their government if necessary – the ability to prevent the exhaustion
of their IP rights when circumstances warrant it in light of the policies
of intellectual property rights and free trade in goods and services.
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However, as Donnelly points out, genuine harmonisation would require
consistent rulings in determining the validity of exemptions to the rule. This
ambiguity is likely to result in considerable disputation. In practical terms I
do not believe there to be a significant difference between the proposed
hybrid models. In either case, a policy review committee would need to be
established in which each product class would be examined and the
economic, commercial and welfare implications considered.
Representations and submissions would be sought from all interested
parties after which, balancing the costs and benefits, a position would be
reached regarding the exhaustion of IPR and parallel imports.
In the rule of reason model, this process would be initiated by the IPR
owner or their territorial agent. In the alternate hybrid model, the process
would be initiated by government, which would conduct a policy review
over a period of time, investigating each product class sequentially. The
latter was the approach taken by the Australian government on the issue of
the exhaustion of IPR and parallel imports, which first ruled on books, then
sound recordings, and more recently passed the Copyright Amendment
(Parallel Imports) Bill 2002, which will effectively adopt the principle of
international exhaustion on all copyright products.14 As a net-importer of
copyright product, it is not in Australia’s national interest to overprotect
intellectual property. See Figure 1 for the welfare-protection trade-off and
the redistribution of income from consumers to producers as the breadth and
depth of the range of exclusive rights is extended. In the Australian
governments’ estimation (and a view held by the Australian Competition
and Consumer Commission (ACCC)), a prohibition on parallel imports
would lower national welfare, since the benefits to (largely foreign)
copyright owners would be smaller relative to the losses imposed on
consumers as a result of higher domestic prices. The adoption of
international exhaustion could be depicted by a movement from zA (see
Figure 1) toward z* raising national welfare from wA to w*. In an action
initiated by the ACCC, the Australian Federal Court found a number of
MNE record companies guilty of breaches of the Trade Practices Act 1974,
resulting from conduct designed to stifle parallel trade by, among other
things, threatening to withdraw supply to music retailers engaging in
parallel importing. The breaches were symptomatic of unwillingness by
foreign copyright owners (acting through domestic subsidiaries) to accept
intra-brand competition brought about by amendments to copyright law
permitting parallel importation. Strategies to retain copyright owner control
over vertical distribution included attempts to block both parallel exports
and parallel imports.15
In an investigation of the cultural dimensions of the TRIPS Agreement,
Samuelson (note 7) contends that the objective of the developed countries
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was to bring IPR within the dispute resolution framework of the WTO. This
would ensure that national governments enact and implement laws that
prohibit piracy and counterfeit. Samuelson expresses concern over the use
of TRIPS as a means of harmonising IPR laws if it leads to further
international acceptance of the ‘freedom imperialism’ already embodied in
the WTO. She contends that the artistic and cultural nature of many
copyright products may provide justification for specific national laws that
protect products that are deemed to be of national cultural significance.
substantial harmonization of national intellectual property laws may
be difficult to achieve unless one wished to bring about a
homogenized global culture of mediocrity in which commodification
and free trade are dominant values.
The potential distortion of economic activity and resources resulting from
the importation right, a form of non-transparent trade barrier, clearly
warrants further investigation to determine its relevance in the
contemporary trading environment. Indeed, while copyright has
historically been defined on a territorial basis, there are two contemporary
developments that will render these practices obsolete in the near future.
The first development is the integration of the global market and the
continuing establishment and extension of free trade areas. A good
example of the latter is the EU ‘Rental Directive’, which allows
individuals or companies to purchase and import copyright goods from
any EU member country, irrespective of the territorial jurisdiction of the
copyright licence holder from which they are purchased. That is, the EU
applies a notion of community exhaustion. No doubt contractual
arrangements between copyright owners and licensees within the EU are
adapting to this changing regulatory environment. This would add some
credence to the argument that the conflict between the territorial licence
holder and the parallel importer is a contractual problem between the
copyright owner and the licensee. Secondly, changes in digital technology
and the Internet provide for the direct sale of copyright material to
consumers in other territorial jurisdictions, while on-line delivery of
digital quality sound recordings will challenge traditional means of
promoting and distributing sound recordings.
Exclusive territorial licences mean that, in practice, parallel importation
is severely restricted. This provides the copyright holder, often the local
subsidiary of an MNE, with exclusive importation and distribution rights.
This exclusivity may impact upon the structure of the domestic market,
influence prices and quantity traded and cause a redistribution of income
between copyright owners and consumers and between foreigners and local
citizens. We now review related literature investigating the economics of
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parallel imports generally with a view to developing a theoretical model of
parallel imports with respect to sound recordings.
Having established that there is no legal impediment to the adoption of
international exhaustion, we now examine the economic literature on the
phenomenon of parallel imports and the issue of national versus
international exhaustion. An investigation of the economic costs and
benefits of parallel imports should enable us to determine whether or not,
policy wise, international exhaustion is superior to national exhaustion.
Summary and Conclusions
Copyright law is an essential safeguard for creators and producers of
entertainment products. However, there is considerable controversy
surrounding the nature of the bundle of exclusive privileges bestowed by
these statutory rights. International IP law does not mandate the adoption of
national exhaustion with respect to copyright products. As such, individual
national governments are free to adopt national or international exhaustion
and can do so across all product classes or selectively, considering the unique
characteristics of the specific market to which it is applied. This is an
important aspect of international trade law that will impact upon the
distribution of entertainment products, and the ensuing market prices, the
distribution of income between consumers and owners of copyright product,
and on economic efficiency. The adoption of international exhaustion will
enable the establishment of competing distribution channels for
entertainment products. Whether this raises or lowers economic efficiency is
a somewhat complex question, the answer to which depends on the unique
market characteristics of the entertainment product in question. Accordingly,
the Australian approach of selective international exhaustion, after a detailed
analysis of the specific product market, seems a sensible approach.
NOTES
1.
2.
3.
4.
5.
6.
I. Clarke and M. Owens, ‘Trademark Rights in Grey Markets’, International Marketing
Review 17/3 (2000), 272–86.
C. Koboldt, ‘Intellectual Property and Copyright Protection’, Journal of Cultural
Economics 19/2 (1995), 131–55.
W.M. Landes and P.A. Posner, ‘An Economic Analysis of Copyright Law’, Journal of Legal
Studies XVIII (1989), pp.325–63.
Office of Regulation Review, An Economic Analysis of Copyright Reform (Australian
Industry Commission, 1995).
A.E. Burke, ‘How Effective are International Copyright Conventions in the Music
Industry’, Journal of Cultural Economics 20 (1996), 51–66.
J. Revesz, ‘Trade Related Aspects of Intellectual Property Rights’, Staff Research Paper,
Productivity Commission, Australia, 1999.
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7. P. Samuelson, ‘Implications of the Agreement on Trade Related Aspects of Intellectual
Property for Cultural Dimensions of National Copyright Laws’, Journal of Cultural
Economics 23 (1999), 95–107.
8. N.N. Weinstock, ‘Asserting Copyright’s Democratic Principle in a Global Arena’,
Vanderbilt Law Review 51/2 (1998), 217–329.
9. Inquiry into the Prices of Sound Recordings, Price Surveillance Authority, Australia 1990;
A. Capling, ‘The Conundrum of Intellectual Property Rights: Domestic Interests,
International Commitments and the Australian Music Industry’, Australian Journal of
Political Science 31/3 (1996), 301–20; D. Richardson, ‘Copyright and Monopoly Profits:
Books, Records and Software’, Current Issues Brief 5 (1996), Canberra, Commerce and
Industrial Relations Group; T. Papadopoulos, ‘Copyright, Parallel Imports and National
Welfare: The Australian Market for Sound Recordings’, Australian Economic Review 33/4
(2000), 337–48.
10. For an economic analysis of the rationale for an importation right, see T. Papadopoulos,
‘The Economic Case against Copyright Owner Control over Parallel Imports: The Market
for Sound Recordings’, Journal of World Intellectual Property 6/2 (2003), 329–57.
11. D.E. Donnelly, ‘Parallel Trade and International Harmonization of the Exhaustion of Rights
Doctrine’, Computer and High Technology Law Journal 13 (1997), 445–515.
12. M. Bronckers, ‘The Exhaustion of Patent Rights under WTO Law’, Journal of World Trade
32/5 (1998), 137–59.
13. D. Nimmer, ‘The End of Copyright’, Vanderbilt Law Review 48 (1995), 1385–1420.
14. The Australian Parliament passed this bill in December 2002, but it has since been deferred
for consideration by the Senate. Its passage is uncertain since the Government does not hold
a majority in the Senate and the opposition party and independents express opposition to the
Bill.
15. T. Papadopoulos, ‘Copyright Law and Competition Policy: International Aspects’, Agenda
9/2 (2002), 113–20.